Abstract
We test the empirical validity of the three-factor model of Fama and French in the Egyptian Stock Exchange (EGX) using monthly excess stock returns of 50 stocks listed on the EGX from January 2014 to December 2018. Our findings do not support Fama and French three-factor model, where the coefficient of the beta was insignificant. The “SBM” coefficient and the “HML” coefficient were equal to zero and insignificant, which confirms the absence of the small firm effect and book-to-market ratio effect in the market. We conclude that there is no relation between expected return and Fama-French risk factors.
Highlights
The capital assets pricing model (CAPM) developed by Sharpe (1964) and Lintner (1965) aims to answer the question how we can price securities taking into consideration the risk and the return; this principle was developed by Harry Markowitz (1952)
This study aimed to explain the relation between expected excess returns and the market premium as well as the value factor measured by the book-tomarket equity ratio, which is calculated by taking the average excess return on a portfolio with a high ratio of book-to-market stocks minus the average excess return on a portfolio with a low ratio of book-to-market stocks, and company size measured by market capitalization, which is calculated by taking the average return on the portfolios with small market capitalization stocks minus the average return on the portfolios with big market capitalization stocks
The results show that the mean return of the value factor (HML) equals zero; this indicates that there is no difference between the return on the portfolio with high BE/MEratio and the portfolio with low BE/ME-ratio, and this is in conflict with the threefactor model, which states that the stocks with high book-to-market equity ratios have high returns compared to stocks with low book-to-market equity ratios
Summary
The capital assets pricing model (CAPM) developed by Sharpe (1964) and Lintner (1965) aims to answer the question how we can price securities taking into consideration the risk and the return; this principle was developed by Harry Markowitz (1952) This model takes into account only one risk factor to show that variation in excess returns: the market beta, which reflects the sensitivity to excess market portfolio return (Market premium). Based on the results of their previous studies, Fama and French (1993) concluded that the variation in stock returns could be explained by three risk factors These factors are the market beta coefficient, the size of the firm, and book-to-market equity ratio. Fama and French constructed a model known in the finance literature as the Fama and French three-factor model, which is used for explaining the variation in stock returns by employing these three factors as the explanatory variables
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